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February 14, 2011 The Cognitive Dissonance of it All "Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one." ‐ Charles Mackay, Extraordinary Popular Delusions and the Madness of Crowds. Dear Investors: We continue to be very concerned about systemic risk in the global economy. Thus far, the systemic risk that was prevalent in the global credit markets in 2007 and 2008 has not subsided; rather, it has simply been transferred from the private sector to the public sector. We are currently in the midst of a cyclical upswing driven by the most aggressively pro‐cyclical fiscal and monetary policies the world has ever seen. Investors around the world are engaging in an acute and severe cognitive dissonance. They acknowledge that excessive leverage created an asset bubble of generational proportions, but they do everything possible to prevent rational deleveraging. Interestingly, equities continue to march higher in the face of European sovereign spreads remaining near their widest levels since the crisis began. It is eerily similar to July 2007, when equities continued higher as credit markets began to collapse. This letter outlines the major systemic fault lines which we believe all investors should consider. Specifically, we address the following: • Who is Mixing the Kool‐Aid? (Know your Central Bankers) • The Zero‐Interest‐Rate‐Policy Trap • The Keynesian Endpoint – Where Deficit Spending and Fiscal Stimulus Break Down • Japan – What Other Macro Players have Missed and the Coming of “X‐Day” • Will Germany Go All‐In, or is the Price Too High? • An Update on Iceland and Greece • Does Debt Matter? While good investment opportunities still exist, investors need to exercise caution and particular care with respect to investment decisions. We expect that 2011 will be yet another very interesting year.